Using American Depository Receipts to Identify the Effect of Price Limits

Many stock exchanges set up certain limits on the maximum variation that a stock is allowed to have in a single day. Table 1 gives an overview of the price limit rules of some of the world exchanges. As reflected in the table, among stock exchanges in 41 countries that we obtain information, 23 of them have price limits and 7 of them have some kinds of circuit breaker rules. The normal assertion of having price limits is to control wild price fluctuation and to foster an orderly market. Whether price limit has such effect is an unsettled issue. In this study, we investigate what effects the price limits may have on a stock return series. To identify such effects, we use a “natural-experiment”: we compare the return series of the same stock that is traded on two different exchanges where there are price limits on one exchange but not on the other. In particular, we use stocks of Japanese companies that are traded both in the United States markets in the form of ADRs and on the Tokyo Stock Exchange (TSE). The shares of ∗The corresponding author. Email: [email protected], phone: (512)475-8540.